Article Highlights:

• Reason for Conversion
• Basis
• Depreciation
• Cash Flow versus Tax Profit or Loss
• Passive Losses
• Home Gain Exclusion

There are many reasons to convert a home into a rental, such as to ensure that a prior home produces income and appreciation after the owner buys a new home; to maximize the tax benefits for an elderly person who can no longer live alone by delaying the sale of that person’s home; and to ensure that a home provides value when its owner takes a temporary job assignment in a different location. Some homeowners even mistakenly think that, when a home has declined in value, converting it into a rental can allow them to deduct that loss. Regardless of why an individual makes such a conversion, a number of tax issues come into play as a result of that decision.

Basis – The basis of the converted property is a good starting point for examining these conversion-related tax issues. The basis is the starting value that is used to calculate gains or losses for tax purposes. The basis is also used to determine the amount of depreciation that can be claimed. Generally, for depreciation purposes, a property’s depreciable basis on the date of the conversion is the lower of its adjusted basis (the original cost, plus the value of any improvements, minus the deducted casualty losses) or its fair market value (FMV).

When a home’s FMV is less than its adjusted basis on the date of conversion, as in Example #2, the rental has dual bases:

Depreciation – Depreciation is an allowance that both accounts for wear and tear and provides a systematic way for the owner to recover the initial investment in the property. This is necessary because tax law doesn’t allow homeowners to deduce the entire cost of a residential rental at one time. Despite this statutory allowance for the depreciation of residential rentals, real properties have historically appreciated rather than depreciated, so this allowance typically provides a significant tax advantage (i.e., a write-off). Here is how to determine the depreciation for a residential rental: First, reduce the basis by the value of the surrounding land (as land is not depreciable) to get the value of the improvements to the home; then, multiply that value by .03636 (the depreciation rate). Generally, the value of the land is based on a property-tax statement. For example, if a property-tax statement values an entire property at $240,000 and its land at $80,000, then 1/3 of the basis ($80,000 / $240,000) is allocated to land; the remaining 2/3 is allocated to improvements. Thus, if the basis is $300,000, then the depreciable improvements are valued at $200,000 (2/3 × $300,000), and the annual depreciation deduction is $7,272 (.03636 × $200,000).

Rental Cash Flow versus Taxable Profit or Loss – Cash flow is the net amount after subtracting expenses from rental income, and the taxable profit or loss is the rental income minus any allowable tax deductions. Of course, higher cash flow is always better, but it is particularly important to avoid having a rental with a negative cash flow. The following example compares cash flow to taxable income.

The major difference between cash flow and taxable income is that cash flow includes the deduction for the entire mortgage payment (not just the interest) but does not include the deduction for depreciation. In the above example, the rental has $1,600 in positive cash flow for the year but also has a passive loss (tax write-off) of $3,372.

Passive Losses – Losses from residential rental real estate are classified as passive and can only offset passive income; deductions from passive losses are also limited to $25,000 per year for most taxpayers with adjusted gross incomes (AGIs) of $100,000 or less. This limit is then ratably phased out for AGIs up to $150,000. Thus, taxpayers’ ability to benefit from a tax write-off on a rental is dependent upon their AGIs. The good news is that the passive losses in excess of this limit carry over to future years and can be used to offset other passive income in those years; in addition, any unused carryforward amount and any passive losses in the sale year are deductible in full once the rental is sold.

Home Gain Exclusion – IRC Section 121 allows homeowners to exclude up to $250,000 of gains from a home sale if they owned and used that home (as their primary residence) for at least 2 of the 5 years prior to the sale date. The amount that can be excluded jumps to $500,000 for married couples who are filing jointly – provided that both have used the property as a primary residence for 2 out of the prior 5 years and at least one has owned the property for 2 out of the prior 5 years. This is a very important consideration because, once a home is converted into a rental, the homeowner(s) will lose the ability to exclude gains after 3 years (because at that point, it is no longer possible to meet the 2-out-of-5-years qualifications).

Even when a homeowner sells a rental property after its conversion but before the exclusion expires, any depreciation that was claimed during the rental period must be recaptured as taxable income.

As shown above, there are many important tax issues related to converting a home into a rental, even aside from the problems related to acting as a landlord. Please call this office if you need assistance with these tax issues or would like help deciding whether to convert a home into a rental.

September 16 – S Corporations

File a 2018 calendar year income tax return (Form 1120S) and pay any tax due. This due date applies only if you requested an automatic 6-month extension. Provide each shareholder with a copy of K-1 (Form 1120S) or a substitute Schedule K-1.

September 16 – Corporations 

Deposit the third installment of estimated income tax for 2019 for calendar year

September 16 –  Social Security, Medicare and withheld income tax

If the monthly deposit rule applies, deposit the tax for payments in August.

September 16 – Nonpayroll Withholding/

If the monthly deposit rule applies, deposit the tax for payments in August.

September 16 – Partnerships

File a 2018 calendar year return (Form 1065). This due date applies only if you were given an additional 5-month extension. Provide each partner with a copy of K-1 (Form 1065) or a substitute Schedule K-1.

September 30 – Fiduciaries of Estates and Trusts

File a 2018 calendar year return (Form 1041). This due date applies only if you were given an extension of 5 1/2 months. If applicable, provide each beneficiary with a copy of K-1 (Form 1041) or a substitute Schedule K-1.

We’re not out to steal their money — just their time. When fraudsters call to say we’re about to be arrested for tax debt, our Social Security number has been “suspended,” or a loved one is in trouble, we play along.

This gives us valuable insight into how the scams operate, while wasting the time these jerks could spend victimizing more vulnerable people.

We have our work cut out for us. Government-imposter frauds have scammed people out of at least $450 million since 2014, according to the Federal Trade Commission. Interestingly, people ages 20 to 59 are more likely to report being defrauded this way than those 60 and over, but older people tend to lose more money. The median individual reported loss was $960, but it was $2,700 for people 80 and older, the FTC said in a July report.

You don’t have to engage with the bad guys to help thwart them. Answering the phone when scam artists call can put you on a “sucker list” that will prompt more calls.

But you can sign up for free “watchdog alerts” from AARP’s Fraud Watch Network, report scam attempts to the FTC and warn loved ones about the latest schemes, such as these three.

Government impostors

Fraudsters are nothing if not flexible. As media coverage of IRS-imposter calls increased last year, scammers switched to impersonating Social Security investigators. The crooks often use software to spoof caller ID services into showing phone numbers for the Social Security Administration or its fraud hotline.

Doug Shadel, AARP’s lead researcher on consumer fraud, recently pretended to take the bait. He returned a robocall from a group of these impersonators and was told the FBI was about to arrest him for opening 25 fraudulent bank accounts. To help the “investigators,” Shadel was advised to move all the money in his legitimate bank accounts to prepaid cards issued by “government-certified” stores such as Apple, Target, CVS or Walgreens. Then, Shadel was supposed to give the caller the cards’ serial numbers so the information could be added to his “file” — allowing the bilkers to steal the money.

Details of these scams might seem absurd, but con artists are exceptionally good at creating an atmosphere of fear and urgency so you’ll react emotionally, Shadel says.

“Once you’re in that state of fear, it swamps all reason,” he says.

Variations on this scheme include warnings that your Social Security number has been suspended because of suspicious activity or that your help is needed to investigate a crime, such as immigration fraud. Know this: Social Security numbers can’t be suspended, investigators typically don’t enlist civilians, and government agencies don’t call out of the blue, says Kathy Stokes, director of AARP’s fraud prevention programs.

“Anyone calling from the government saying there’s a problem and you owe money is a scam,” she says.

Source: https://www.marketwatch.com/story/scammers-get-more-creative-watch-for-these-new-phone-and-email-rip-offs-2019-08-16?mod=personal-finance

Article Highlights:

• Tax Loss for a Security Sold or That Is Worthless
• Proving Worthlessness
• Selling a Worthless Stock by Year-end
• Brokers May Accommodate Clients
• Capital Loss Deduction

If you are like most investors, you occasionally will pick a loser that declines in value. Sometimes, a security can even become worthless when the issuing company goes out of business.

Gains and losses for securities, including stock, stock rights, bonds, debentures, and similar debt instruments, are not recognized for tax purposes until the securities are sold or become worthless. If the security is sold for a loss, the date of loss is easily determined since it is the sale date. However, for worthless stocks, it is not that easy to determine the date of loss, and taxpayers cannot just pick the year they want to for claiming the loss.

The IRS says a stock is worthless when a taxpayer can show that the security had value at the end of the year preceding the deduction year and that an identifiable event caused a loss in the deduction year. Just because an issuing company has filed bankruptcy does not necessarily mean its stock is worthless in that year. The company could be in reorganization, or the stock might not be worthless until a later year.

Whatever you do, don’t wait until it’s too late to take your loss. If the IRS challenges the loss and the security is found to have become worthless in an earlier year, the current year’s loss will be denied. Your only recourse at that point is to amend your prior year’s return to claim your loss, provided the three-year statute of limitation has not expired. If the loss is claimed too early, the IRS will also deny it (making you wait until a subsequent year when the stock actually becomes worthless).

Talk to your broker before the end of the year if you have holdings that have lost all, or nearly all, of their value and you want to be able to claim your investment in them as a loss on your 2019 return. Most brokerage firms will purchase worthless stock for a nominal amount (one cent) just to provide closure for their clients. This is probably the best solution for tax purposes. The sale will appear on Form 1099-B issued by the broker, and then you won’t have to debate with the IRS over when the stock became worthless.

As a reminder, losses from sales of capital assets such as stock are first used to offset any capital gains on the return for the year of the sale. If the amount of the gain isn’t enough to absorb all of the losses, up to $3,000 ($1,500 if married filing separate) can be used to offset other types of income. If there is still capital loss remaining, it is carried forward to the next tax year and, if necessary, to future years, until it is used up.

Article Highlights:

• Trading in a Vehicle
• Selling a Vehicle
• Gifting a Vehicle
• Donating a Vehicle to Charity

If you are buying a new car, are you wondering what to do with the old one? You actually have a number of options, some of which have tax implications and some of which don’t. These options include trading the car in with the dealer, selling it to a third party, donating it to a charity, gifting it to someone, or even keeping it as a second car. Here are the details for each. Note: This article does not discuss in detail how to treat the disposition of a vehicle used for business.

Trade-In – Although you may be able to get more for your car by selling it yourself, trading the car in with the dealer eliminates the hassle of selling the vehicle and is the option selected by many people when they purchase a new car. Prior to the passage of the tax reform, if a vehicle was used partially for business and the disposition of that vehicle would have resulted in a gain, it was better to trade the vehicle in because the tax law allowed the gain to be deferred. However, that is no longer an option, and now, whether you trade in your vehicle or sell it to a third party, it is treated as a sale.

If a car has been used 100% for personal purposes (no business use), whether you trade it in or sell it generally makes no difference since, except in rare cases, the vehicle will have declined in value and there would be no gain from the transaction. When there is a loss from the sale of personal-use property, tax law does not allow the loss to be deducted. On the other hand, the law says that when a personal-use item such as a vehicle is sold for a profit, the profit is taxable.

Sell the Vehicle – In this Internet age, a variety of online sites exist with firms that will let you know the value of your used vehicle; an example is Kelly Blue Book. There are also used car dealers that will buy your car and relieve you of all the DMV transfers and sales tax issues. Of course, you can sell it yourself through online sites such as Craigslist or perhaps by just placing a “for sale” sign in the car, in which case you need to make sure the title is properly transferred so you have no future liability. You also need to be cautious of potential buyers, to make sure someone does not try to scam you with a hot check or the promise of a future payment. In most states, vehicle sales are “as is” sales, provided you do not attempt to conceal a material defect.

Gift It to Someone – It is quite common for individuals to gift their old car to a child, a family member, or an acquaintance. There are no gift tax ramifications as long as the fair market value (FMV) of the vehicle is less than the annual gift tax exclusion amount ($15,000 for 2019). Where a married couple jointly makes the gift, the annual gift tax exclusion applies to each spouse; thus, the vehicle’s value could be as much as $30,000 without any tax ramifications. If the vehicle’s FMV exceeds those limits, a gift tax return is required. The gift is not allowed as a charitable contribution on the former owner’s income tax return, even if the person to whom the car is given is “needy.”

Donate the Vehicle to Charity – You’ve probably seen or heard ads urging you to donate your car to charity. But donating a vehicle may not result in a big tax deduction or any deduction at all. A few years back, this was a popular type of charitable donation promoted by many charities. However, vehicle donations were so abused by taxpayers claiming values higher than what the vehicles were worth that Congress had to step in. The result is a number of rules that, in some cases, limit the amount of the charitable deduction to $500.

The deduction is limited for motor vehicles (as well as for boats and airplanes) contributed to charity whose claimed value exceeds $500 by making it dependent upon the charity’s use of the vehicle and imposing higher substantiation requirements.

If the charity sells the vehicle without any “significant intervening use” to substantially further the organization’s regularly conducted activities or without any major repairs, the donor’s charitable deduction can’t exceed the gross proceeds from the charity’s sale of the vehicle. Examples of qualifying significant intervening use include delivering meals every day for a year or driving 10,000 miles during a one-year period while delivering meals.

The gross proceeds limitation on a donor’s auto contribution deduction doesn’t apply if the charity sells it at a price significantly below FMV (or gives it away) to a needy individual. This exception applies only if supplying a vehicle to a needy individual directly furthers the donee’s charitable purpose of relieving the poor and distressed or the underprivileged who need a means of transportation. In this case, the fair market of the vehicle is used to determine the amount of the contribution.

Additionally, a deduction for donated vehicles whose claimed value exceeds $500 is not allowed unless the taxpayer substantiates the contribution with a contemporaneous written acknowledgement from the donee. To be contemporaneous, the acknowledgment must be obtained within 30 days of either (1) the contribution or (2) the disposition of the vehicle by the donee organization. The donor must include a copy of the acknowledgment with the tax return on which the deduction is claimed.

Acknowledgement by the donee organization must include whether the donee organization provided any goods or services in consideration of the vehicle as well as a description and a good -faith estimate of the value of any such goods or services or, if the goods or services consist solely of intangible religious benefits, a statement to that effect. Form 1098-C incorporates all of the required acknowledgement elements for the donee (charitable organization) to complete. The donor is required to attach copy B of the 1098-C to his or her federal tax return when claiming a deduction for contribution of a motor vehicle, boat, or airplane.

U.S. citizens and residents with a financial interest in or signature or other authority over any foreign financial account need to report that relationship by filing FinCEN Form 114 if the aggregate value of the accounts exceeds $10,000 at any time during the year. The due for 2018’s report was April 15, 2019, with an automatic 6-month extension to October 15, 2019. Failure to file can result in draconian penalties. Form 114 is filed electronically with the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) BSA E-Filing System and not as part of the individual’s income tax filing with the IRS.

Keep in mind that “financial account” includes securities, brokerage, savings, checking, deposit, time deposit, or other accounts at a financial institution. Commodity futures and options accounts, mutual funds, and even non-monetary assets such as gold are also included. It becomes a “foreign financial account” if the financial institution is located in a foreign country. If you own shares of a foreign stock or a mutual fund that invests in foreign stocks, and the stock or fund is held in an account at a financial institution or brokerage located in the U.S., this is not considered a foreign financial account, and the FBAR rules don’t apply to it. An account maintained with the branch of a foreign bank physically located in the U.S. also is not a foreign financial account.

You may have an FBAR requirement and not even realize it. For instance, perhaps you have relatives residing in a foreign county and they have put you in their bank accounts in case something happens to them. If the combined value of those accounts exceeds $10,000 at any time during the year, you will need to file the FBAR. Or if you are gambling on the Internet, that online casino may be located in a foreign country, and if your account exceeds the $10,000 limit at any time during the year, you will have an FBAR reporting requirement.

You may also have an additional requirement to file IRS Form 8938, which is similar to the FBAR requirement but applies to a wider range of foreign assets with a higher dollar threshold. If you are married and you and your spouse file a joint return, you must file Form 8938 if the value of certain financial assets exceeds $100,000 at the end of the year or $150,000 at any time during the year. If you live abroad, the thresholds are $400,000 and $600,000, respectively. For other filing statuses, the thresholds are half of those amounts. The penalty for failing to file the 8938 is $10,000 per year, and if the failure continues for more than 90 days after you receive an IRS notice of failure to file, the penalty can go as high as $50,000.

As you can see, not complying with the foreign account reporting requirements can have some very nasty repercussions. Please call our office with questions or if you need assistance in meeting your foreign account reporting obligations.

The Federal Reserve’s decision to cut interest rates 25 basis points for the first time in over a decade marked a dramatic shift in monetary policy.

It will be felt by Americans across the board.

After raising the federal funds rate nine times in three years, with the last move coming in December as financial markets were melting down, concerns about a slowing economy caused the Federal Open Market Committee and Chairman Jerome Powell to reverse course.

Now, interest rates are historically low, which leaves the central bank with little wiggle room in the event of a recession or if the economy stumbles. The current target range for its overnight lending rate is 2% to 2.25%.

For consumers, the so-called Powell Pivot could mean a reprieve in escalating borrowing costs, which can impact your mortgage, home equity loan, credit card, student loan tab and car payment. At the same time, savings account rates may fall.

Here’s a breakdown of what may happen to your loans and savings:

Credit cards: Interest you pay may go down a bit

Savings: Depositors get squeezed

Mortgages: Time to consider a refi

Auto loans: Shoppers have more room to negotiate

Student loans: Some good news for grads with private loans

Article Highlights:

• Income as a Factor
• Filing Status as a Factor
• 85% Maximum Taxable
• Base Amounts
• Deferring Income
• Maximizing IRA Distributions

Whether your Social Security benefits are taxable (and, if so, the amount that is taxed) depends on a number of issues. The following facts will help you understand the tax ability of your Social Security benefits.

• For this discussion, the term “Social Security benefits” refers to the gross amount of benefits you receive (i.e., the amount before reduction due to payments withheld for Medicare premiums). The tax treatment of Social Security benefits is the same whether the benefits are paid due to disability, retirement or reaching the eligibility age. Supplemental Security Income (SSI) benefits are not included in the computation because they are not taxable under any circumstances.
• The amount of your Social Security benefits that are taxable (if any) depends on your total income and marital status.
•  If Social Security is your only source of income, it is generally not taxable.
•  On the other hand, if you have other significant income, as much as 85% of your Social Security benefits can be taxable.
•  If you are married lived with your spouse at any time during the year, and file a separate return from your spouse using the married filing separately status, 85% of your Social Security benefits are taxable regardless of your income. This is to prevent married taxpayers who live together from filing separately, thereby reducing the income on each return and thus reducing the amount of Social Security income subject to tax.
• The following quick computation can be done to determine if some of your benefits are taxable:
  Step 1. First, add one-half of the total Social Security benefits you received to the total of your other income, including any tax-exempt interest and other exclusions from income.

  Step 2. Then, compare this total to the base amount used for your filing status. If the total is more than the base amount, some of your benefits may be taxable.

  The base amounts are:

• $32,000 for married couples filing jointly;
• $25,000 for single persons, heads of household, qualifying widows/widowers with dependent children, and married individuals filing separately who did not live with their spouses at any time during the year; and
• $0 for married persons filing separately who lived together during the year.

Where taxpayers can defer their “other” income from one year to another, such as by taking Individual Retirement Account (IRA) distributions, they may be able to plan their income so as to eliminate or minimize the tax on their Social Security benefits from one year to another. However, the required minimum distribution rules for IRAs and other retirement plans have to be taken into account.

Individuals who have substantial IRAs—and who either aren’t required to make withdrawals or are making their post-age 70.5 required minimum distributions without withdrawing enough to reach the Social Security taxable threshold—may be missing an opportunity for some tax-free withdrawals. Everyone’s circumstances are different, however, and what works for one may not work for another.

If you have questions about how these issues affect your specific situation, or if you wish to do some tax planning, please give us a call.

In the largest possible sense, handling the cash flow for your new business is exactly what it sounds like ‒ you’re trying to get the clearest level of visibility into “money coming in versus money going out” as possible. But managing cash flow is also about a lot more than that, too. It’s about making sure that you not only have the funds on hand to “keep the lights on” and to remain operational, but that you can also capitalize on opportunities as they arise instead of watching them pass you by. It’s about making sure you have access to what you need to not only put your best foot forward today, but to better prepare yourself for challenges that may develop six months or even a year from now, too.

All of that is to say that the importance of gaining a precise understanding of your cash flow cannot be overstated.

Indeed, running out of money is also one of the most common ways that new businesses in particular are forced to close their doors ‒ usually very quickly after their initial launch. But while this is certainly an essential topic, it isn’t necessarily a difficult one. Properly managing the cash flow for your new business is a lot more straightforward than you might be fearing ‒ you just need to keep a few key things in mind.

The “Breakeven” Point

By far, one of the most important metrics for you to understand about your new small business is your “breakeven” point ‒ that is, the point at which your current (or projected) revenues will allow you to meet all of your operating expenses. This is the bare minimum amount of money you need to keep your employees paid, to keep your bills up-to-date and to keep your doors open ‒ and unfortunately, it usually changes on a regular basis.

As your business continues to scale, your revenue should increase ‒ but your expenses will increase, too. Therefore, it is of paramount importance that you don’t make finding your “breakeven” point something you “do once and forget about.” For the best results, you should return to this figure on a regular basis to make sure you: a) understand what it is in the literal sense; and b) understand what actions you need to perform to actually achieve that.

Once you have a handle on your breakeven point, you’ll at the very least be able to remain functioning ‒ which means you can start to devote more of your attention to actually growing into the type of business you want to be running in the first place.

The Importance of Cash Reserves

If you take a look at some of the other reasons why small businesses usually fail, you’ll quickly see that they’re closely related:

• About 79% of businesses fail because they start out with too little money, according to one study.
• 77% run into troubles when they fail to price properly, or don’t include all necessary items when setting prices.
• 73% close because they were either too optimistic about achievable sales, about the money required to generate those sales, or both at the same time.

These types of issues are common with small businesses, and particularly with those controlled by an entrepreneur who may be running their first SMB to begin with. But for as much as all of these ideas ultimately tie directly back into cash flow management, they also underline another very important best practice to that end:

The Value of Maintaining a Cash Reserve

• Absolutely every new business ‒ regardless of its size or the industry it’s in ‒ should expect problems to crop up on a regular basis. Entrepreneurship is very much one of those areas where “Murphy’s Law” rules the day. Working hard to keep a quality cash reserve will not only help lessen the ultimate impact of those problem times, but it can also help reduce stress and distractions, too.
• If you have no cash reserve, every problem becomes a major cash flow problem. But at the very least if you have something to fall back on, you have the clarity you need to learn from the situation and double down with your focus on growing your business moving forward.

Take Control of Those Receivables

Typically, new businesses don’t have a problem with the “money out” side of cash flow management. Even if business leaders do start to spend money too quickly, hopefully, they’re in a position to recognize it so that they can do something about it as soon as possible.

But it’s difficult to “do something about it” if you’re not bringing any money in, which is why taking control over your receivables is so important.

If a client owes you $1,000, but you have no idea when they’re going to pay it, do you really have $1,000? No, not really ‒ which is why you should try to make any invoices “due immediately” if you can. If someone does need some more time to pay, try to make sure the terms give them no longer than a week or two at most. This is the future of your business that we’re talking about, after all.

Depending on your specific clients, you may even want to offer discounts for people who pay early. This can be a great way to incentivize them to get those invoices paid and to get that essential money into YOUR proverbial pocket.

At a bare minimum, you should have someone on staff who is tasked with maintaining visibility into receivables and who can follow up with customers who have yet to pay in a stern-yet-friendly way.

The more money you bring into the business, the more money you can spend on those initiatives that will continue driving your organization forward.

Every Dollar Spent Has a Purpose

Everyone knows that you should really only spend money on essentials, but in the fragile early days of a new business, you need to take that concept one step further.

With every last purchase you make, you need to be able to SEE the verified return on investment that it will bring with it. If you’re buying a new piece of equipment, what does it actually get you? Will it speed up your production, allowing you to more quickly achieve a larger volume of higher quality finished products? In that case, the return on investment absolutely justifies the initial money you need to spend.

However, if you really want that new piece of equipment simply because it’s the “latest and greatest,” that isn’t really the “good idea” you thought it was.

Another example of this would be investing in a new payment solution that allows you to accept payments online. It may not be a “fun” purchase with company money, but if it allows you to expand into a true e-commerce solution and open up new opportunities to make sales over the internet, it therefore becomes an “essential,” and that is a step worth taking.

In absolutely no uncertain terms, you cannot afford to spend money “just for the sake of it.” Figure out what your essentials are and make sure you have the cash on hand to actually support them. Then, go through and eliminate the costs to anything that isn’t essential ‒ at least until your business is in a fully profitable state.

In the end, remember that properly managing your cash flow is something you need to be proactive about. Not only do you have to intimately know where you are today, but you also need visibility into where you’re headed tomorrow, too. When everything is functioning as it should be, your cash flow best practices should be supporting the former while making the latter possible.

If they aren’t, there is a serious issue with your current process that you will need to find and eliminate as quickly as you possibly can.

Article Highlights:

• Home Equity Loan
• Home Equity Interest Deduction
• Alternative Minimum Tax
• Above-the-Line Interest Deduction
• Qualified Expenses

If you are considering borrowing funds to finance your college education or that of your spouse or children, it is important that you understand that the student loan interest deduction is not limited to the interest paid on government student loans. In fact, virtually any loan interest will qualify as long as the loan proceeds are used solely for qualified higher-education expenses (that is, it is a sole-purpose loan).However, the maximum interest that is deductible each year is $2,500. Thus, in addition to government student loans, home equity lines of credit, personal loans from unrelated parties, and even credit cards can be used if they otherwise qualify. Pension plan loans and loans from related parties do not qualify.

If a loan is not subsidized, guaranteed, financed, or otherwise treated as a student loan under a program of the federal, state, or local government or an eligible educational institution, a payee (the lender) must request a certification from the payer (the borrower) that the loan will be used solely to pay for qualified higher-education expenses. Form W-9S, Request for Student’s or Borrower’s Social Security Number and Certification, is provided by the IRS for this purpose.

You can claim a deduction for student loan interest whether you claim the standard deduction or you itemize your deductions since it is an adjustment to income, often referred to as an above-the-line deduction.

To qualify as an eligible loan, the loan must have been taken out solely to pay the costs of attending an eligible educational institution for an individual during a period when the individual is a qualified student. Eligible costs include:

• Tuition
• Fees
• Room and board
• Books and equipment
• Other necessary expenses (including transportation)

The expense must be incurred within a reasonable time before or after the debt is incurred. The regulations provide that a loan is incurred within a reasonable period if:

• The expenses are paid with the proceeds of a loan from a federal post-secondary education loan program; or
• The expenses are related to a particular academic period and the loan proceeds used to pay the expenses are disbursed within a period that begins 90 days prior to the start of, and ends 90 days after the end of, that academic period. A home equity line of credit can be used to meet these requirements by paying education expenses as they become due, provided that the loan is not used for any other purpose.

Such expenses must be reduced by the following:

1. Income excluded from employer-provided educational assistance;
2. Income excluded from U.S. savings bonds used to pay higher-education expenses;
3. Nontaxable distributions from Coverdell ESAs; and
4. Scholarships, allowances, or other payments (such as distributions from Sec. 529 plans) that are excludable from gross income.

Eligible educational institutions – Eligible educational institutions are colleges, universities, and vocational schools eligible to participate in the Department of Education’s student aid programs (in other words, virtually all accredited public and private post-secondary schools). In addition, institutions conducting internship or residency programs leading to degrees or certificates awarded by a higher education institution, a hospital, or a healthcare facility that offers postgraduate training also qualify.

Eligible student – An eligible student is one enrolled in a degree or certificate program who is at least a half-time student. What constitutes half the normal course load will be determined by the definition of the school being attended. Generally, a full-time student is one carrying at least 12 units.

Who Claims the Interest – The above-the-line interest deduction may only be claimed by a person who is legally obligated to make the payments on the qualified educational loan. However, tax regulations allow payments on above-the-line education interest made by someone other than the taxpayer/borrower to be treated as a gift, allowing the interest to be deductible by the taxpayer.

Not Available to Higher-Income Taxpayers – The deduction is ratably phased-out for taxpayers with an AGI (income) of $70,000 to $85,000 ($140,000 to $170,000 for joint returns) and not allowed at all for taxpayers filing as married separate or an individual who is a dependent of another. The amounts shown are for 2019; contact this office for the amounts for other years.

If you are considering borrowing money to pay for higher-education expenses, it may be appropriate to consult with us since there are other limitations.